Bitcoin has been reaching new highs in 2023, prompting questions about whether the market is overextended and if we’ve reached the peak of enthusiasm. To answer these questions, examining the positioning of the crypto options market provides valuable insights.
A fitting comparison for Q4 2023 is the rally observed in Q4 2020. By comparing BTC returns for both years, a remarkably similar narrative unfolds. Currently, the implied volatility of options, indicating an investor’s bet on BTC’s future realized volatility, is near its 2023 peak, driven mainly by the buying of call options. This could suggest that the market is already factoring in the explosive upside potential.
However, when looking at BTC’s implied volatility over the past four years, it remains relatively subdued, implying that BTC hasn’t demonstrated the explosive rally it is historically capable of. For instance, during BTC’s surge in Q4 2020, option volatility peaked at around 150%, while today it stands at approximately 50%.
A comparison between the historical futures basis today and that of January 1, 2020, reveals significant disparities. The futures basis on Deribit in 2020 was 20% annualized, equivalent to 17 times the 10-year risk-free rate. In contrast, today’s futures basis is around 10% or 2.4 times the equivalent risk-free rate. While these differences don’t necessarily predict higher spot prices, they suggest that potential buying power is still largely on the sidelines.
It’s crucial to note the connection between the implied volatility option traders are willing to pay and the actual volatility that BTC is experiencing (realized volatility). This relationship, known as the Variance Risk Premium (VRP), has been widening since mid-October. Option traders have consistently been willing to pay a significant premium over realized volatility in BTC, anticipating the possibility of explosive movements.
An interesting development is the implied volatility “kink” higher for the January option expiration month. This reflects the anticipation that the Securities and Exchange Commission will make decisions regarding spot Bitcoin ETFs, potentially causing significant market movements.
The forward volatility, which represents the actual implied volatility differential between the Dec. 29 expiration and the January contract, currently sits around 57%, a 12-point premium over the 30-day realized volatility of 45%. This situation raises questions about whether option buyers are making incorrect and overpriced bets or if substantial volatility in BTC will not only continue but grow larger.
This information is not legal advice. Do your own research before making any decisions. Only invest what you can afford to lose and seek independent financial advice if needed. Understand the risks involved before purchasing any cryptoassets.